Storage Predicament

USDA's February 8, 2002 Supply and Demand Report offered little new information. Supply and demand predictions for corn and wheat were unchanged from the January report-slightly positive for corn since many thought there could be a reduction in export projections. Small increases in soybean crush and export estimates reduced projected ending stocks to 270 million bushels. There also were only small changes in global supply and demand estimates. These small changes don't offer much encouragement for those with 2001 corn and soybeans in storage.

Soybeans: In recent years, basis strengthening (narrowing of spread between cash and futures prices) and small post-harvest futures price rallies combined to provide the opportunity for short-term storage gains.

Basis strengthening has occurred again this year-usually a market signal to move cash grain. However, these basis gains have been largely offset by lower futures prices and, with the exception of brief periods in November and January, cash bids have not provided the opportunity to recover storage costs let alone capture storage gains. Little additional cash price strength should be expected, since current cash bids represent a basis that is stronger (narrower) than average in many Missouri locations.

Opportunities for a futures price rally are limited. It appears that another large crop is nearing harvest in South America. This foreign export competition, along with uncertainty over GMO rules in China, suggests that U.S. exports may slow down. Domestic demand is strong, but supplies appear adequate with an ending stocks projection that is still somewhat above average (last 10 years). Short of a major reduction in planted acreage or unexpected demand, it appears that only summer weather problems could cause a significant price rally.

Storage costs will continue to add up. Assuming an 8 percent interest rate and per bushel storage costs of $0.01 per month in on-farm storage or $0.03 per month in commercial storage, it has already cost $0.15 to $0.25 per bushel to store soybeans. Storing the soybeans into summer (late June-early July) in hopes of capturing a weather rally will double these costs.

Continuing to store soybeans appears to be risking weaker cash prices and increased storage costs while betting on the weather for higher prices. This creates a dilemma about what to do with stored soybeans-especially if the LDP has been claimed. One alternative is to simply give up on higher prices and minimize losses (while basis remains strong) by selling the soybeans. For those still hoping for higher prices, selling the soybeans to take advantage of strong basis and buying call options to re-own the beans also seems to be a better strategy than continuing to store. This reduces risk of weaker basis and the premium for an at-the-money July soybean call compares favorably with storage costs. Soybean price outlook and the market signals are negative, only those willing and able to accept additional losses should continue to speculate with stored soybeans.

Corn: At first glance the corn situation appears similar to soybeans. Stronger corn basis has been offset by generally declining corn futures prices. The stronger cash prices have only produced, at best, breakeven prices with the cost of storage. If the corn is in commercial storage, current prices may result in negative returns. However, the market signals are not all negative.

Carry (premium for distant month futures prices) in the corn market still suggests some potential storage returns. Domestic demand is projected at record levels and ending stocks will decline. Exports have been the major drag on the corn market, but disappointing crops are reducing the potential for Argentine and South African competition. Adequate supplies and the possibility of increased production have also weighed on prices. However, exports may be showing some signs of perking up and a surprise in planting intentions or poor spring/summer growing conditions could produce a significant rally.

Storage risks exist for corn, but many analysts tend to be more optimistic about risking storage of corn than they do soybeans. Selling corn to capture basis gains and re-owning with options also might be a good strategy, especially if the corn is in commercial storage. The premium for a July call option compares favorably with commercial storage costs, however, buying the July call would give up market carry. So far, it has not been possible to capture storage profits and storage gains still depend upon a price rally that may or may not occur. The decision to continuing storing requires an acceptance of the lower-price risk and possible storage losses.

Foxes, Henhouses and Cash Contracts

A number of grain merchandisers are offering what some call "new generation grain marketing contracts." These new forward cash contracts are managed programs designed to "simplify" marketing for farmers. The programs allow the farmer to focus on production, while "marketing professionals" work to achieve an above average net price. To many producers, frustrated by low prices and uncertain markets, locking in a pre-harvest price that is above average seems to make good business sense. However, some marketing advisors caution that letting the buyer do the selling is like "putting the fox in charge of guarding the henhouse!"

Seasonal-price patterns provide clues for timing of forward contract sales. Corn and soybean prices typically rally from winter lows into spring planting season. Prices often slip after the crop is planted and off to a good start, then rally again as late spring/early summer weather conditions raise production concerns. After the early summer rally, prices generally decline to harvest time lows. Historically, prices for pre-harvest sales made during the spring and early summer have been better than prices at harvest time. Most of the new contracts are based on pre-harvest sales and use "price windows" to capture prices during the spring and early summer seasonal rallies.

While there are a variety of names for the new contracts, the pricing methods usually include averaging or some form of automated pricing rules. In addition, some offer managed futures/options hedging or "Plus" contracts that include the potential for additional price gains above the averaged prices. The average contracts simply average sales over a specified pre-harvest time window, attempting to average prices during seasonal periods of stronger prices. Automated pricing rule contracts use target prices, minimum prices and/or other pricing rules to trigger sales based on price action during a specified period. Managed hedging contracts include using futures/options based on recommendations of a specified market advisory service. "Plus" contracts are an averaging or automated pricing contract with an additional share of a professional's hedging profits. "Plus" contracts include a fee for the professional and may include an additional incentive for the professional for prices in the top one-third of the price range.

The new contracts may provide some market pricing advantages over other forward cash contracts. The averaging and automated pricing rule contracts provide a disciplined plan to capture seasonal market trends. The managed hedge and "plus" contracts enable precise following of the marketing plans and recommendations of professional marketing firms. For producers who are uncomfortable using futures/options or those who would like to shift marketing responsibilities to someone else during busy production seasons, the new contracts may offer services that can improve their net price.

Critics are concerned that new generation contracts could have negative impacts on cash price. They argue that the buyer's best interest (buying cheap) conflicts with the producer's best interest (selling high). In addition, cash contracts include a commitment to deliver the grain to the buyer. Required delivery reduces marketing flexibility and contracted grain becomes "captive supply" to the buyer. This committed supply could produce negative impacts on basis and the resulting net price, because the buyer doesn't have to raise cash bids to attract grain delivery. This lack of flexibility and potential negative impact on basis along with contract fees may more than offset price gains from the various pricing strategies.

The marketing strategies, used by the new generation cash contracts, may seem complicated; but they are not "rocket science." A disciplined marketing plan utilizing a variety of marketing tools can accomplish the same objectives without a delivery commitment. Producers, who choose to use the new generation contracts, should make sure they understand how the contracts work. It is important for a farmer to decide whether committed delivery, contract fees and potentially weaker basis are offset by a disciplined approach to better prices or whether it is simply "letting the fox into the henhouse!"